This week Representative Cory Gardner (R-CO) will introduce a bill called the EARN act. This bill seeks to reduce the number of improper payments in the Earned Income Tax Credit (EITC) and use the savings to expand the credit for eligible taxpayers.
One of the biggest issues with the EITC is its high rate of error. From fiscal years 2003 to 2013, the rate of error—the percent of payments that were made to people not eligible, or overpayments to those who are eligible—accounted for around 21 to 30 percent of all payments. This has cost the Treasury an additional $136 to $163 billion over the past ten years.
As a basis for comparison, the SNAP program (food stamps), had an error rate of just under 3.5 percent in 2012.
Estimated EITC Improper Payments for Fiscal Years 2003 Through 2013
Minimum Improper Payments Percentage
Maximum Improper Payments Percentage
Minimum Improper Payments, 2013 Dollars (Billions)
Maximum Improper Payments, 2013 Dollars (Billions)
There are two reasons for these high rates of error. First, since this is essentially a spending program with a number of rules determining eligibility, it is likely that people are making errors in regard to whether they are eligible and how much they are eligible for.
The second reason for the errors are fraud, either by the taxpayer themselves, or by a tax preparer misrepresenting their income or other information in order to receive a larger credit.
Representative Gardner’s bill seeks to reduce errors by approaching both fraud and waste. It will expand what is called “math error authority” for the EITC. This allows the IRS to correct math errors on the part of the taxpayer that causes them to claim credits that are too large or too small. The bill also increases the penalties for fraud including high monetary penalties and a longer disallowance period.
Assuming that the math error authority works and the penalties are sufficient enough to prevent fraud, the bill will use the saved money to expand the EITC for eligible taxpayers, though it is not yet clear exactly how much will be available or how much the expansion will be per taxpayer.
The EITC isn’t perfect and its high level of error is concerning. Reducing error—as this bill aims to do—is a positive thing. It will increase the efficiency of the program and makes sure the tax dollars are going to those they were meant to reach.
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Last Wednesday, Governor of Connecticut Dannel P. Malloy (D) announced that the primetime game show Who Wants to Be a Millionare? had moved its production to Connecticut from New York to take advantage of film tax incentives. Although this seems like a win for Connecticut, the gains are small compared to the overall cost of the tax incentive program.
Since 2007, Connecticut has spent an average of $62 million per year on film tax credits, the 8th highest in the nation. But it is unclear whether Connecticut’s long-time residents and taxpayers benefit from this incentive program.
The move of Who Wants to Be a Millionaire? is lauded thanks to the 150 new above-average-wage jobs which are expected to accompany the show. While it’s true that average wage incomes of film and television production jobs are higher than the national average private sector job, these employment gains are restricted to Stamford, a city in southwest Connecticut. It’s hardly fair that all of Connecticut’s citizens will have to subsidize employment gains from which most will derive no benefit. Plus, 150 jobs is a vanishingly small economic impact considering that Connecticut has over 1.6 million private sector workers. Such narrowly-targeted incentives are unlikely to drive broad-based economic prosperity for the whole state.
Putting localized economic benefit to the side, Connecticut’s film tax incentive program is simply bad policy. Out of all industries, why should film and television be subsidized? While it may be a “landmark” industry that is important to Connecticut’s citizens, there are other landmark industries like oyster harvesting or firearms manufacturing that do not receive such generous treatment, and yet oyster harvesters loyally remain in the state. Second, the tax incentives tend to disproportionally benefit new firms which make new investments, like Disney-ABC currently. This breeds a cycle of new firms making investments and receiving credits, while mature pay the whole cost of the tax bill. Third, the tax credits decrease the costs of production for shows like Who Wants to Be a Millionaire?, encouraging companies to spend more making these shows than they otherwise would have. These companies make excessively risky investments in worker training and infrastructure, knowing that they will fully benefit from the success of these investments while their failure will be partially subsidized. This is both economically unsound and unfair to other industries that bear the full cost of their mistakes.
Finally, and perhaps most significantly for a state like Connecticut with a large film and media industry, the tax credit program creates distortions within these industries. In defining “qualified recipients,” the legislation discriminates between certain programs, excluding programs such as news, weather, and financial reports. Although these programs may not be as popular as Who Wants to Be a Millionaire?, excluding them from benefiting from the credits is simply arbitrary and eventually leads to a suboptimal amount of these kinds of programs.
Even if Connecticut understands the weakness of this policy, its policymakers could be reluctant to scale back or eliminate it because of national competition. Many states provide generous film tax credits, and the cutting of subsidies might put Connecticut in danger of losing film production companies to these states. However, there are ways of mitigating this hazard other than an incentives-driven race to the bottom. Lowering Connecticut’s overall high business tax burden instead of providing carve-outs for special interests would allow the state to retain and even attract valuable establishments. Lower rates and broader bases can help support broad economic growth benefiting all Connecticut residents, not just a few select firms.
When states like Connecticut unhealthily compete for transient benefits that end up bettering only select companies at the expense of everyone else, the entire nation loses. This kind of lose-lose interstate competition is actually why the Constitution provides Congress the power to regulate interstate commerce. But by replacing a system of high rates and numerous carve-outs with broad tax bases and low tax rates, Connecticut could create a more conducive climate for all businesses, not just film production.
Read more on film incentives here.
Read more on Connecticut here.
California’s legislature voted this week to offer $420 million in tax incentives to Lockheed Martin in order to locate production of a new stealth bomber in California (specifically at Lockheed’s existing Palmdale facilities). The situation is complicated. Northrop Grumman and Boeing are competing for the rights to the $55 billion stealth bomber contract (Northrop Grumman currently produces stealth bombers) and both have major production operations in California. If Boeing wins the contract, Lockheed Martin, also with large California facilities, will be the main subcontractor for Boeing.
Narrow incentives such as these are not sound tax policy. They rarely succeed in their aims of “creating” jobs, and create major distortions as existing companies foot the full freight of the tax bill in order to provide incentives to other favored firms and new investments. California in particular has been seriously disadvantaged by film credits in other states, and has experienced much debate over its own film incentive program. But the recent incentives for Lockheed Martin illustrate particularly well why narrow tax incentives are not just bad policy, but also ineffective.
The Lockheed Martin deal was only made possible by a compromise promising to offer the same deal to Northrop Grumman if they win the contract. This is the theater of the absurd in tax incentives. California gave the deal to Lockheed in order to give them a cost advantage over Northrop Grumman so they could compete better to get the bomber contract from the Air Force. By offering the same deal to Northrop, California has neutralized its own policy, returning Northrop and Lockheed to exactly the same relative competitive positions as they occupied before incentives. These incentives are just treading water for no reason.
Offering state tax incentives as a way to compete for federal military contracts is peculiar in its own right. In effect, $420 million of the cost of developing the new stealth bomber will be paid by California’s state government. Plus, military contractors have widely-recognized incentives to ensure that production facilities are located in many different states and congressional districts, and can only use facilities that meet certain security guidelines, and their main customer (the government) is financed by taxes anyways, so they can likely easily build taxes into the cost of their product. In other words, military contractors are almost certainly one of the industries with the least sensitivity to state tax policies (along with government employment itself).
Essentially, California has declared that it will offer $420 million to anybody who will promise to build stealth bombers in Palmdale. Northrop Grumman, Boeing, and Lockheed Martin all already have facilities in Palmdale, and have historically worked on stealth fighters and bombers in those exact facilities, so it was always likely Palmdale would be the site of any new stealth production. Just to make it crystal-clear, Northrop Grumman has already announced they will produce the new bomber in California, even before an incentive package has been voted on, so incentives seem particularly unlikely to matter. By offering incentives to both companies already located in the state, California is mostly competing against itself, and doing so at a price of $420 million.
Major aerospace production involves a large number of highly-paid, high-skilled workers, so it’s understandable why policymakers would be tempted to provide large tax incentives, even when those incentives are poor policy. But especially in this case, tax incentives are almost certainly going to result in costs to California’s state government while having next to no influence on where the new bomber will actually be produced (Northrop Grumman, for example, would still locate much of the design and engineering in Florida), while Lockheed Martin or Northrop Grumman get to benefit from California’s robust public services without pulling the same weight as other California companies.
Read more on California here.
Read more on tax incentives here.
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Rum, like all spirits, falls under a federal excise tax of $13.25 per proof-gallon. The federal tax revenue collected from rum produced in Puerto Rico, the U.S. Virgin Islands, or internationally is transferred to the governments of Puerto Rico and the U.S Virgin Islands. This transfer of revenue from the United States back to the location of production is called a “cover-over.”
Puerto Rico and the U.S. Virgin Islands each receive all of the revenue collected from rum produced in their territory. The two countries split revenue from foreign produced rum, based generally on how much rum they produce relative to each other. By producing more rum, each territory has the ability to increase their share of the rum tax.
When rum is produced in the U.S. Virgin Islands they are awarded all of the federal excise taxes collected on that rum. If the rum is produced in Puerto Rico, the U.S. Virgin Islands receive nothing. The amount of rum one country produces relative to the other also determines their share of the tax revenue from international production.
Increased rum production in the U.S. Virgin Islands, relative to Puerto Rico (or vice versa), increases the country’s share of cover-over payments from taxes on foreign produced rum. This strong incentive to boost local production for tax revenue from international production has led to a subsidies war between the two territories.
Over the past decade the U.S. Virgin Islands has steadily increased subsidies to bolster rum production. The island’s native producer, Cruzan, receives a subsidy equivalent to 46.5 percent of the tax revenue collected on the company’s rum. Last month Cruzan told the island’s government they would need larger subsidies to survive.
In 2008 the U.S. Virgin Islands subsidized rum producer Diageo’s move to the island (manufacturer of Captain Morgan). Totaling an estimated $2.7 billion over 30 years, the subsidies include: a new $165 million distillery, “market support payments” to keep prices low for molasses (the main ingredient in rum), 35 percent of what Diageo spends on advertising, a 90 percent income tax break, exemption from property taxes, environmental mitigation supports, and 47.5 percent of all tax revenue collected on Captain Morgan rum. By one estimate, Diageo’s net cost to produce rum is zero.
Compounding perverse subsidy incentives, the rum cover-over program has created budgeting shortfalls. The treasuries of Puerto Rico and the U.S. Virgin Islands are reliant on these federal transfers as part of their yearly revenue.
A 1984 law capped the cover-over of the rum tax at $10.50 per proof-gallon, but since 1993 temporary tax extender legislation has removed this cap. The unpredictable biennial reauthorization process of tax extenders often leaves the territories with uncertain revenues. The U.S. Virgin Islands face a $30 million dollar deficit for fiscal year 2014, due to lower rum revenues, if the federal extenders package is not approved.
Unpredictability of tax extenders is only half of the budgeting uncertainties faced by the island nations. Because the distribution of the rum tax is dependent relative production, when rum production changes so does cover-over revenue. In 2005, the U.S. Virgin Islands received $81.1 million from the cover-over program and Puerto Rico received $419.6 million. In 2012, the U.S. Virgin Islands received $256 million (a significant increase) and Puerto Rico received $376 million (a $43 million decrease).
Contributing to the U.S. Virgin Islands’ increase in cover-over payments, and Puerto Rico’s decrease, was rum producer, Diageo’s, relocation from Puerto Rico to the U.S. Virgin Islands. Fluctuations in rum cover-over payments are the product of shifting rum production from one territory to the other – this wreaks havoc on local budgets.
The unintended consequences of the cover-over program have led both Puerto Rico and the U.S. Virgin Islands to manipulate their economies to maximize federal subsidies. The ensuing subsidies race distorts the economy, creates perverse incentives, and destabilizes local government.
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The House is voting this afternoon (maybe this minute) on permanent bonus depreciation, which would allow all businesses to immediately expense 50 percent of investments in equipment and software with the remainder to be written-off according to the normal depreciation system. We have argued that expensing is ideal for investment and economic growth. Our simulations indicate that bonus depreciation (partial expensing) would grow GDP over 1 percent, the capital stock over 3 percent, wages by about 1 percent, and would create 212,000 jobs. Higher wages and more jobs would cause tax revenue to increase by $23 billion per year. That is, it’s a tax cut that pays for itself, in the long run.
Now it appears the Joint Committee on Taxation (JCT) agrees with us to a large degree. Using their dynamic models, they find that bonus depreciation would grow GDP about 0.2 percent in the long run, and this in turn would boost tax revenue. Unfortunately, JCT does not provide much precision in their results, so it is hard to tell how much more tax revenue they are predicting. From their numbers (see page 22), it appears somewhere between 50 to 120 percent of the static revenue losses would be recovered through economic growth. That is, it could pay for itself.
JCT does find a smaller economic growth impact than we do, apparently because they are assuming a large share of businesses are unprofitable or are carrying forward losses and so wouldn’t be able to take advantage of bonus depreciation (see footnote 49). Hopefully JCT is not basing this off of a post-financial crisis year, such as 2009 or 2010 when current losses and losses carried forward were huge. We base our predictions off a normal year, 2008, and assume the economy will return to such normalcy eventually.
In any case, it is good to see JCT using their dynamic models for economically important proposals such as bonus depreciation. And good to see those model results are largely in agreement with ours, indicating that bonus depreciation would provide a boost to investment, GDP and tax revenue.
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Nearly 5,000 backers from across the world have chosen Brown’s potato salad project, and tens of thousands of dollars will be dished to Brown on August 2. But once these funds are given to Brown, they will constitute income that might mean a sizeable tax bill for Brown. Kickstarter explains how pledges are taxed:
“In the U.S., funds raised on Kickstarter are considered income… A creator can offset the income from their Kickstarter project with deductible expenses that are related to the project and accounted for in the same tax year. For example, if a creator receives $1,000 in funding and spends $1,000 on their project in the same tax year, then their expenses could fully offset their Kickstarter funding for federal income tax purposes.”
Kickstarter also notes creators “may be able to classify certain funds” as nontaxable gifts instead of income, so long as the funds were pledged with “detached and disinterested generosity,” but one look at Brown’s Kickstarter page shows that these funds probably won’t qualify.
Brown offers donor specific handouts, such as a recipe book with potato salad recipes from every donor country for pledges of $50 (so far 83 backers), potato salad themed hats for pledges of $25 (234 backers), and even a potato salad themed haiku for pledges of $20 (4 backers).
So, given that Brown’s funds will likely be considered income instead of non-taxable gifts, how much will he have to pay in federal, state, and local income taxes?
We will cap the amount of funding he receives at $70,912 (his total as of 2:28pm on July 9, 2014). Kickstarter takes 5 percent (as a finder’s fee) of the total and Brown is able to deduct expenses associated with that income because the income from Kickstarter qualifies as business income.
Let’s say between the finder’s fee of about $3,500 and business expenses of about $1,500 (in order to make recipe books, and potato salad themed hats, pencils and paper to write his haikus, and a bowl for potato salad mixing), Brown’s pre-tax income drops to $65,912.
Now, let’s assume Brown is a single filer that is able to take a standard deduction of $6,200 and a personal exemption of $3,950 in 2014. Also, since this income is self-employed income, we must calculate Brown’s payroll tax burden, which is $9,313.07. We then take half of this amount ($4,656.53) and, along with the standard deduction ($6,200) and personal exemption ($3,950), deduct it from his taxable income. This gives Brown $51,105.47 in taxable income.
Next, Brown will have to face the U.S.’s progressive tax system. Brown’s first $9,075 dollars will be taxed at a rate of 10 percent. His next $27,824 in income will be taxed at 15 percent. His remaining income will be taxed at a rate of 25 percent. This puts his federal income tax burden at $8,632.22, and his effective federal income tax rate on his Kickstarter funds of $65,912 will be 13.1 percent.
But wait, there’s more. As a resident of Columbus, Ohio, Brown also faces city and state taxes. On his taxable income of $51,105.47, he must pay $1,510.20 in city taxes and $1,712 in state taxes.
And let’s not forget his payroll taxes. As we mentioned earlier, Brown owes $9,313.07 in payroll taxes on his self-employment income. This is calculated from the first dollar of after expenses income of $65,912.
In total, Brown’s federal, state, and local tax burden on his income of $65,912 is $21,167.49 for an effective tax rate of 32.11 percent, leaving him with take home pay of $44,744.51 less taxes and expenses.
So while the pledges continue to stream in, it’s important to remember there will be a tax bill on any profit Brown retains. Given that Brown’s “Big Stretch Goal,” is to “rent out a party hall and invite the whole internet” to a potato salad party, this fundraising effort is a good start.
Update (7/11/2014): Kickstarter has updated the funding totals (currently around $48,000 at 2:25pm). According to The Business Journals, the boost in total funds resulted from some fake pledges which have now been removed. Stay tuned, and we will update the final numbers once the remaining 21 days have expired.
Income and Taxes Paid by Zach Danger Brown
The Potato Salad Maker From Kickstarter
Source: Tax Foundation Estimates
As of 2:28pm, Wednesday, July 9, 2014
Income Minus Expenses and 5% Finders Fee
Payroll Tax Burden
Total Tax Burden
Effective Tax Rate
After Tax Income Less Expenses
By Aditya Kalra NEW DELHI (Reuters) - Sonia Gandhi, president of India's ousted Congress party, on Wednesday accused the new Narendra Modi-led government of a "political witch hunt" after tax authorities began probing her party as she and her son face allegations over misusing funds. The Gandhis are the torchbearers of a dynasty that has led India for most of its post-independence era since 1947 but that was dealt its worst ever election defeat by Modi in the general election that ended in May. Last month an Indian court summoned Sonia and her son Rahul to answer allegations that they used $15 million of party funds to pay off debts accrued by a now defunct newspaper publishing business several years ago. A Congress official said the party had received "notices" from India's tax authority, a communication in which the recipient is asked to explain apparent irregularities in his tax declarations. The official said the notices pertained to income tax and were related to the court case involving Gandhi and her son, although he did not give further details.
Senator Debbie Stabenow (D-MI) and Senator John Walsh (D-MT) plan to reintroduce the Bring Jobs Home Act (S. 2562). The act would provide a tax credit for 20 percent of a firm’s costs incurred bringing jobs back to the United States. Sen. Stabenow first introduced the act in 2012, though it failed to pass the Senate.
While politically popular due to the conventional wisdom that U.S. companies are “shipping jobs overseas,” this act rests on a flawed assumption: that companies have shipped jobs overseas, thus making it possible to bring them back. In fact, the data say otherwise.
Shortly after the release of the bill in 2012, we put together data on total layoffs and layoffs due to job relocations from the Bureau of Labor Statistics (though it’s important to note that the BLS is not always able to track where jobs are moved).
The data showed that, for years 2008 to 2010, relocations (shifting jobs from one location to another) comprised between 3 and 4 percent of total mass layoffs (layoffs of 50 workers or more). Among the small amount of layoffs that can actually be attributed to relocation (3 to 4 percent), the majority of moves happened between states, not countries.
In fact, the proportion of out-of-country relocations dropped from 33 percent in 2008 to 29 percent in 2010 of all relocations with a known destination. Additionally, relocations out of the country make up less than 1 percent of total layoffs and dropped from 0.75 percent of total layoffs to 0.49 percent from 2008 to 2010, with most relocations happening within the same company.
This trend continued in 2011 and 2012. The total amount of layoffs occurring due to relocations (domestic and international) declined in 2011 and 2012, only accounting for 2.8 percent and 2.2 percent of total mass layoffs, respectively. Within those jobs lost due to relocation, the amount of jobs being “shipped overseas” declined from 0.34 percent of total layoffs in 2011 to 0.21 percent in 2012, with most relocations still occurring within companies.
While the total number of layoffs is down in recent years, the chart and table below show that layoffs resulting due to job relocation have decreased in recent years. Over the same time, the number of jobs moved overseas continue to make up less than half a percent of total layoffs.
The first time we discussed this in 2012, the conventional wisdom that US companies were “shipping jobs overseas” had little basis in fact. Two years later, with 2011 and 2012 data as evidence, this trend is becoming stronger as an even smaller proportion of mass layoffs are occurring due to any form of relocations (4 percent down to 2.2 percent), and even fewer of these jobs are being relocated overseas (from 0.75 percent down to 0.21 percent).
While the second iteration of the Bring Jobs Home Act may still play well politically, there is little reason for the tax credit the act would create. In fact, the credit would likely result in a windfall for companies that claim the credit for jobs they planned to create without it.
Instead of political gimmicks, policymakers should focus on real reforms that grow the economy and create jobs here at home.
Mass Layoffs and Separations Resulting from Movement of Work
Source: Bureau of Labor Statistics
Total private Nonfarm layoffs
Layoffs Not Due to Relocation
Total Layoffs from Movement of Work (Domestic and International)
Percentage of Total Layoffs
Layoffs from Domestic Relocation
Domestic Relocations as Percent of Total Layoffs
Jobs Relocated Overseas
Overseas Relocations as Percent of Total Layoffs
Overseas Relocations within Company
Overseas Relocations to Different Company
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This week the House will take up a bill that will permanently extend what is called “bonus depreciation,” or 50 percent expensing. 50 percent expensing was one of the over 50 “extender” tax provisions that expired at the end of last year.
50 percent expensing allows businesses to immediately write off, or expense, 50 percent of an investment in new equipment or short-lived structures. It does not apply to commercial or residential buildings or factories.
We find that permanently extending this provision would boost GDP by over 1 percent, wages be 1 percent, and create 212,000 new jobs due to its effects on the cost of capital. It would also increase federal tax revenues by $23 billion after taking into account the increases wages and incomes caused by making bonus expensing permanent.
While these things are certainly good, calling the provision a bonus is a little misleading. It is a bonus compared to current law. Businesses can write off more of their investment sooner and the economy as a whole will see more investment and growth compared to current law; however, bonus depreciation more accurately represents only a partial move to a more neutral tax base. An ideal, neutral tax code (a tax code that treats saving and investment equally) would allow businesses 100 percent expensing on all capital investments rather than 50 percent expensing on some investments.
Under current law, when a business makes a capital investment (purchases a machine, building, or office equipment), it must write off, or deduct these costs from taxable income in stages over several years or decades.
For example, suppose a pizza shop purchases an oven for $100. Under the current cost recovery system, an oven is deducted in stages over 7 years according to a depreciation schedule. Each year’s deduction is a percent of the total initial cost (table, below). Over the expected life of the investment, each year’s deductions add up to the initial nominal cost of $100 when the oven was purchased.
However, in present-value terms, this isn’t the case. If we take into account the time-value of money and inflation, the pizza shop will actually not be able to deduct the initial cost of the investment over seven years. In fact, the pizza shop will only be able to deduct $83.63 in present-value terms over the life of the investment. For the business this means their taxable income over the seven years is inflated related to what is should have been. For the economy as a whole, this means an increase in the cost of capital, reduced investment, and slower economic growth.
Depreciation Schedule of a 7-year Asset (MACRS)
Present Value Write-off
Note: 5 percent real discount rate and 2.5 percent inflation
50 percent expensing is an improvement over current law. This provision allows a business to immediately deduct 50 percent of the initial cost before using the above depreciation schedule. For the pizza shop, this means a $57 deduction for the oven on the first year. This also means that because a larger deduction was taken in the first year, the pizza shop will be able to recovery more of the initial cost of the investment over the 7 years ($91.82 with bonus depreciation vs. $83.63 without bonus depreciation) after we take into account the time value of money and inflation. This represents a reduction in the cost of capital in contrast with current law. This is why our analysis finds a boost to GDP, wages, and employment.
Depreciation Schedule of a 7-year Asset (MACRS) with 50% Expensing
Present Value Write-off
Note: 5 percent real discount rate and 2.5 percent inflation
However, $91.82 in present-value terms is still not $100. So even with 50 percent expensing, we are not at the ideal in which a business can recover the full cost of an investment.
An Ideal tax code would allow the full $100 cost of the oven to be deducted in the year in which it was purchased. Allowing businesses to expense, or deduct the full cost of an investment immediately, would lower the cost of capital and increase investment even more.
We found that full expensing will increase GDP by 5.21 percent, wages by 4.42 percent, and federal revenue by $96 billion. A benefit to GDP five times greater than a permanent bonus expensing provision.
So yes, bonus depreciation is a bonus compared to current law and a step in the right direction towards a neutral, pro-growth tax system, but full expensing is still the ideal.
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